Technical Analyst Sees Emerging Markets Taking Over

Markets

Fundamental analysts get lost in their perspective and ignore charts, where technical analysts at least are looking at the right thing. They can get lost in their charts though.

Stock analysts are quite content to do their analysis and just stop there and make their forecasts. An independent observer might point out that they should not want to just stop there though, like wondering why fundamental analysts don’t look to the market for confirmation of their ideas.

This turns out to be a big mistake, even if they get lucky, because they are foretelling things based upon their beliefs which has to translate to the charts if what they portend will actually happen at some point.

It is the interim period that we need to look at here, from where they call the buy to where the chart says that it is ready, and given that it spends this journey by definition as an underperformer, we are guaranteed to underperform, which we should not want.

They might look at a stock that has been beaten up and predict better times ahead, where we presumably are supposed to be buying it here and hoping that the analyst is right. If the chart disagrees though, this means that while the stock may outperform in the future, it is not happening now. If we want to buy now, we are out of sync with reality.

Technical analysts will look at the chart but ignore the fundamentals, and unless we are trading, how fundamentals are trending does matter to us, with the important word being trending. This approaches fundamentals with a technical perspective as well, seeing the numbers both looking good now and trending in the right direction, the direction that will lead us to greater profits.

While chart analysis can be a good stand-alone strategy with investing as well as trading, when we’re looking at periods of a year or more, fundamentals can provide us with additional insights that can allow us to distinguish between similarly good-looking charts. There are a lot of stocks out there and we can use all the good information we can get to decide between them, and changes in fundamentals is one of the things that we can use if we do so in the right way.

This means leaving our hopes at the door as well as any affection we may have for underdogs, as the dogs that we are interested in aren’t struggling, they are moving their way up the ladder of stock preferences in a way we cannot just hope for but need to measure.

When it comes to looking at indexes, we now dealing with a basket of stocks and we end up with quite a hodgepodge of business results, and need to look at the bigger picture instead, averages, economic fundamentals and other external influencers that all stocks are under, to find the common ground that we need.

What people look at with the indexes is the average price to earnings ratios, which is a tool that can be helpful if used the proper way. The fundamental analysts don’t use it the proper way, and the technical analysts don’t use these things at all, so that leaves neither doing it right.

This is another case where analysts just find something that they think that they can go with and just stop thinking, where a little extra would go a long way. Price to earnings ratios provide us with insight on how much a stock is valued over its earnings, which is another way of saying that this calculates the premium added to stock prices by adding in outlook.

This isn’t a matter of the future expectations of earnings necessarily, as this is really the expectation of the future price of a stock, where ones that we expect will go up more will have a more positive outlook and therefore a higher ratio to current earnings as its outlook over and above current earnings projections improve.

Just looking at the earnings compared to a stock’s price does not in itself predict anything, since both the stock’s price and its earnings are expressed in the present. It does tell us how much of a premium the market has placed on the stock’s future recently, but to get the most out of a static number like this, it must be placed in perspective to observe the trend.

At any point in time, we could see a stock with an above average ratio but one that is on the decline, and this is not something that you want to see because that means the outlook for the future is declining. We do want to see this go up though, because that means the outlook is improving, and riding improving outlooks is the way we make money with stocks.

There’s not a lot of company fundamentals that can help us when we’re viewing stocks in the aggregate, but trends in average ratios is one of them. Where the analysts mess up here is looking where the level is now and thinking that this measuring stick defines things, rather than just measuring this in the context of different investing climates.

Someone might claim that the last time we moved up to this high of an average P/E ratio with the S&P, things reversed, but this did not reverse by itself, there were actual reasons that caused it. For instance, the climate may have changed, and the way that they use this is like worrying about rain and seeing the temperature drop from a certain level in the past as well as it starting to rain and assume that the decline in the temperature caused the rain.

What happens instead is that the probability of rain depends on the upcoming weather patterns, where we go from sunny to partly cloudy, to cloudy, to raining, to storming. It is the weather that matters if you’re looking to predict the weather, and while this ratio has been here before and it may have gone down from there, the weather wasn’t anywhere near as nice as it is right now.

This information can therefore be helpful to guide us, seeing things almost ideal right now for stocks and also seeing this ratio continue to climb. The climate sets the overall outlook, and the ratio continuing to rise confirms the outlook is being translated to higher prices. If either the climate deteriorates or the trend in ratios changes direction, now we’ve got something that should command our attention.

If we rise too fast like we did in the late 1990’s, then we may end up with ratios that get ahead of themselves because they are out of sync with the climate, being too good for the times. The actual risk here is that with steeper rises in both price and this ratio, there can be a much bigger selloff happen, but this current bull market remains nice and steady, which bodes well for its continuance.

This is all just a guide though to have us on the lookout for prices confirming any worry that this might bring us, and we always need to use price as the final determiner, because it is. This is also the case when we’re dealing with indexes such as the S&P 500 or the MSCI Emerging Market Index (EEM).

People are seeing what we could call the fundamentals of U.S. stock indexes, the economy, the Fed, trade, and so on, and things continue to look pretty rosy as far as the eye can see. When we have this in place and we continue to climb up the charts, we can continue to buy and hold with more confidence than either the fundamentals or the technicals could provide on their own.

Emerging markets have been in a real slump since 2007, and the MSCI Emerging Market Index has just gotten clobbered by U.S. stocks ever since. This index still hasn’t recovered from the crash that year and is still off by 17%, while the S&P 500 is up 122% since then.

We also need to look upon more recent activity though, as perhaps this trend is turning around now like some people are predicting that it will. The EEM never made it back to where it was 2 years ago, and still has 11% to go to get there. The S&P 500 is up 16% over the last 2 years, a difference of 27%.

If we look at the last 12 months, we finally get a period where the emerging market index is up, by 11%. The S&P 500 has gained 25% over the last 12 months though. The last 6 months portrays the EEM in its most favorable light, with it going up by 17%, matching the S&P 500 over this time, but still behind the 21% of the Nasdaq.

If we are expecting that emerging markets will take over soon, it’s not happening yet at least, and until this shows us that it can actually beat U.S. stock indexes, all of them, we should not even be thinking about something like this. We should be seeking the best investments, not just grabbing any old fruit off a tree where better ones are also in easy reach.

This is another step that is required that just about everyone misses, for some strange reason actually as this should be intuitive. This is a mistake that is common to both types of analysts, and while some may give this some attention, we can never decide whether or not a stock play is a good one just viewing it in isolation.

Technical Analysts Can Get Things Plenty Wrong Too

What got us interested in doing this article is technical analyst Andrew Addison of the Institutional View promoting the emerging market index lately. He promoted this as a buy last month and is still at it.

He also shares is reasoning, which starts with the fact that this index was so hot for a few years, where it well outperformed U.S. indexes, but fizzled out in 2007 and it just went cold. Addison then assumes that this runs in cycles, in spite of no evidence to show this, and given that we’ve been in a down cycle with this for over 12 years after a 5 year up cycle, he thinks a new one must be due.

People were just jumping on this index with both feet at one time, which we could even call a frenzy, but frenzies end, and aren’t just brought back to life out of thin air. We had the story and the action and the excitement and the move back then, where now there is no story, no action, no excitement, and no move, but somehow this is supposed to be around the corner.

This part of his argument just does not make any sense, but he does point out that then emerging market index has broken out lately with a 12-month high on December 27, along with it having gone up a little more since. He believes that this means we should be buying it, but there’s one important piece missing.

Even if we knew with absolute certainty that this will continue to go up a little like this for a while, this does not mean that we should buy it. Once we find a good play, whether this is one or not, the next question that we need to ask is what the opportunity cost of the investment is, how it measures up to what else we could put the money in.

This is not an optional question if we want to make an honest effort to succeed, but it is amazing how many people tout an investment and don’t even wonder whether it’s even above average. The EEM sure hasn’t been, and as long as this remains, we could be drawing our plays out of a hat and would do better on average.

At a minimum, this requires us to compare to the U.S. indexes and require it to show us that it is moving faster enough and for long enough that we can have our confidence in this index restored enough to want to own it instead.

Perhaps it is more fun to guess but a whole lot of guessing goes on here, although given that our task is to seek out the probable, guessing won’t get the job done. People have been guessing that this bull market will end for quite a while, and all of them have been wrong. We might want to think that this is the year, but without anything concrete to hang our hats on with this, it just continues to blow in the wind.

There is another important aspect in play with this which is also something that we don’t think anywhere near enough about, which is comparing relative risk in addition to relative returns. We usually don’t have much interest in either actually.

The EEM actually fails pretty miserably on both counts, and all you have to consider is that we’re still waiting for this index to make back its losses from 2007, or even to get back to where it was 2 years ago, and that should answer all our questions about the risk part.

Measuring risk dynamically requires us to look at both how much something went down, how quickly it recovered, and how much further ahead we are today. The EEM has done terribly, and this could put us in a situation where if it falls again, we could stay down for years while U.S. stocks continue to blow it out of the water.

The biggest thing that people are missing when it comes to their predictions about U.S. markets is the impact of the buyback craze that we have in the U.S. now. This in itself has the power to put to rest any ideas of investing in something like the EEM again, at least if big buybacks remain the rage, which they likely will for a while at least. Perhaps even more importantly, it sufficiently distinguishes 2020 from past bull markets enough that it could be said that we’ve even entered a new frontier with stocks, where they have become even more bullish than ever, in a sustainable way.

The EEM used to be the life of the party at one time, but has long been pronounced dead. It will take more than people praying over it to bring it back to life enough to run with the real bulls again, little breakout or not.

Eric Baker

Editor, MarketReview.com

Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.